Unit 5 teaching note

Introduction to Fiscal Policy

• Definition: Fiscal policies are tools (revenue and expenditure instruments) adopted by governments to stabilize the economy. It aims to achieve macroeconomic objectives such as full employment, sustained long-term economic growth, and price level stability (Parkin & Bade, 2018).

• Goal: Establish the transmission mechanism through which fiscal policies achieve their objectives and analyze their relative ineffectiveness in dealing with economic shocks and business cycles.

• Focus: Examining fiscal policy responses by G7 countries during the COVID-19 pandemic, with special emphasis on Canada.

Learning Outcomes

1. Discuss trends in revenues and expenditures of the Canadian government and the federal budget process.

2. Distinguish between different types of fiscal policies and budget balances.

3. Explain how fiscal stimulus addresses economic recessions and pandemics like COVID-19.

4. Understand the impact of business cycle fluctuations on the Canadian federal budget and macroeconomic effects.

What is Fiscal Policy?

• Concept: Fiscal policy refers to the use of government instruments (like revenue and expenditure) to influence macroeconomic conditions.

• Implementation: Typically executed through the Federal Budget.

Federal Budget and Process

• Definition: An annual statement detailing government expenditures and revenue generation, outlining laws and regulations for budgetary processes.

• Process Variation: Budget creation differs globally, often depending on a country's governmental system.

  • In Presidential systems: Budget bills are presented by the President for legislative approval.

  • In Parliamentary systems (Canada): Budget creation involves consultations among various stakeholders, leading to a responsible budget proposal presented to Parliament.

• Inclusion: Canada practiced gender budgeting since 2016, focusing on gender-based analysis in budgetary measures.

• Preparation Timeline: Generally six months for budget preparation, but the budget cycle spans about two years.

Budget Events in Canada (Table 1)

• Key dates include budget circulars, fiscal policy statements, and parliamentary votes with an annual financial year starting on April 1.

Federal Budget Sources of Revenue and Expenditure

Components of Federal Budget

• Revenues: Personal income tax (largest share at 50% in 2016), followed by indirect taxes (19.4%), investment income (16.5%), and corporate income taxes (14.3%).

• Expenditures:

  • Transfer Payments: Largest share of expenditures (68% in 2016).

  • Trends show increases in transfer payments, debt interest rates, and relatively stable government spending on goods and services.

Historical Context

• The revenue has fluctuated with economic performance, particularly personal income tax, which is susceptible to the business cycle.

• Corporate income tax is also volatile, with transfer revenues reflecting larger cycles of upturns and downturns in economic conditions.

Budget Balance Overview

• Definitions:

  • Budget Surplus (BS): Revenue exceeds outlays.

  • Budget Deficit (BD): Outlays exceed revenue.

  • Balanced Budget (BB): Outlays equal revenue.

• Historical Trends: Canada has witnessed more deficits historically, particularly during the 1980s and after major economic crises, with a tendency for deficits to occur more frequently than surpluses.

Connection between Deficit and Debt

• Budget Deficit: Occurs when expenditures exceed revenues, leading to government borrowing.

• Government Debt Measurement: Typically presented as a Debt/GDP ratio, indicating the proportion of the economy used for debt servicing.

• Historical Patterns: Trends show that as deficits rise, so does the debt level, reflecting previous periods of accumulated deficits.

Debt/GDP Ratio Issues

• Critique: The Debt/GDP ratio may not accurately reflect correct fiscal health due to GDP underestimation.

• Alternative Measure: The Debt/Government Revenue ratio is proposed to better assess fiscal sustainability and reflect obligations versus actual revenues.

Canada's Fiscal Forecast and Projections

• COVID-19 Impact: COVID-19 led to substantial fiscal spending, with budgetary balance showing significant declines.

  • Projections show revenue and outlays will be notably impacted due to decreased tax revenues from job losses.

Sustainable Debt Level Analysis

• Pre-COVID, Canada maintained a manageable debt level compared to other G7 nations, with effective management strategies for governmental financial assets.

• Outlook: Rising debt levels due to fiscal stimulus measures but effective debt management through lower interest rates is anticipated to maintain fiscal discipline.

Provincial Budget Insights

• Variability in Budget Outlays: Maritime Provinces show higher reliance on federal transfers compared to resource-abundant provinces like Alberta and British Columbia.

Consequences of Income Tax on Economic Dynamics

• Effects of Higher Income Tax: Higher taxes disincentivize labor participation, noticeably impacting overall economic output and real GDP.

Types of Fiscal Policies

• Automatic Fiscal Policies: Triggered by economic conditions without direct intervention (e.g., employment insurance).

• Discretionary Fiscal Policies: Require direct government actions affecting spending and tax laws (e.g., COVID-19 relief measures).

Challenges with Discretionary Fiscal Policy

• Lags: Included recognition lag, law-making lag, and impact lag, illustrating the delays encountered in implementing effective fiscal policies.

Summary of Fiscal Policy’s Role

• Through a comprehensive examination of Canada’s responses to fiscal challenges, students should gain insights into navigating macroeconomic stability during unprecedented times.